Members of the defense bar June 19 expressed dismay over the Securities and Exchange Commission's announcement that going forward, it will drop its “neither admit/nor deny” settlement language in some instances and insist on liability admissions from defendants.

Among other concerns, attorneys told BNA that the move could complicate settlement negotiations, lead to more litigation, and potentially result in inconsistent enforcement practices. Moreover, they questioned the types of cases in which the SEC can obtain admissions.

However, others suggested that the SEC likely will take a cautious approach given the potential significant impact to its enforcement program arising from the policy change.

Policy Interests

SEC Chairman Mary Jo White June 18 announced that going forward, in actions where there is a “need for public acknowledgement and accountability,” the SEC will not allow defendants in settlement agreements to neither admit, nor deny the agency's allegations (118 SLD, 6/19/13). Should the agency fail to obtain an admission, it will refuse to settle and will go to court, she said.

White described the policy change as “incremental” to another revision in early 2012 in which the SEC said it would drop the language in cases in which there are parallel criminal convictions, or admissions by defendants of criminal violations (04 SLD, 1/9/12). White also stressed that the “no admit, no deny” language will remain a useful tool in the agency's arsenal, and will be used in the majority of its resolutions.

The SEC has long used the “no admit, no deny” clause in its settlements. The language has been criticized by several district court judges, including Judge Jed Rakoff from the Southern District of New York. Rakoff's refusal to approve a proposed $285 million settlement between the SEC and Citigroup Global Markets Inc. (C)--partially because the SEC failed to force an admission out of the defendants--now is before the U.S. Court of Appeals for the Second Circuit (229 SLD, 11/29/11). The settlement, if approved, would have resolved the commission's allegations over the firm's role in a questionable 2007 collateralized debt obligation.

In addition, critics have charged that the settlement language has no deterrent effect and does little for Wall Street accountability.

Division Memo

White has strongly defended the “no admit, no deny” practice (114 SLD, 6/13/13). However, she also asked her Enforcement co-directors--George Canellos and Andrew Ceresney--to review the policy (89 SLD, 5/8/13).

According to a June 17 memo that Canellos and Ceresney issued to enforcement staff, the SEC will require admissions where to do so “could be in the public interest.” These circumstances may include:

misconduct that harmed large numbers of investors or placed investors or the market at risk of potentially serious harm;

where admissions might safeguard against risks posed by the defendant to the investing public, particularly when the defendant engaged in egregious intentional misconduct; or

when the defendant engaged in unlawful obstruction of the SEC's investigative processes.Arbitrary Application.

New York-based Covington & Burling LLP partner David Kornblau told BNA that the new policy will result in more litigation and charges of arbitrariness against the SEC. At the same time, the change is unlikely to mollify commission critics, said Kornblau, a former chief litigation counsel in the Enforcement Division.

“The chairman articulated a fuzzy standard for requiring admissions which will inevitably lead to charges of arbitrary application,” he said. “More important, the policy likely will not lead to admissions in the types of cases that have produced the greatest hue and cry for admissions, such as negligence-based actions against investment banks involving only a few sophisticated institutional investors.”

The types of cases more likely to meet the standard are those that generally attract minimal public attention, such as egregious offering frauds, pump and dump schemes, and broker misappropriation cases, Kornblau said.

The SEC's enforcement program is designed to investigate and identify violations, halt them, and prevent recurrences, Gorman told BNA. The “neither admit, nor deny” language facilitated those goals by allowing the agency to speedily settle cases and return funds to harmed investors, while “avoiding the difficulty for the settling party that admissions create in parallel civil damages litigation,” he said.

Without recourse to the language, most defendants will opt to litigate their SEC allegations rather than settle, Gorman continued. Ultimately, the change in policy could undermine the commission's goals in settling actions, and “tax the limited resources of the Enforcement program by requiring that more resources be diverted to a small group of cases.”

Part of Larger Change?

Meanwhile, Ralph Ferrara, a Washington-based partner in Proskauer LLP, suggested that the policy change is part of a bigger, “continuing trend” towards “criminalization” of the Enforcement Division. This is just “another inflection point,” he said.

Ferrara, SEC general counsel from 1978-1981, noted that historically, the SEC's enforcement program was “forward looking, remedial, and prophylactic.” Now, however, it has become increasingly “retrospective, retributive, and penalizing.”

Ferrara said the trend began when the SEC began staffing the division with criminal prosecutors. One example of the “remarkable transformation,” he suggested, is the increase in insider trading actions, and the corresponding decline of cases involving the SEC's historical priorities, such as accounting and financial fraud.

With this new policy change, “they are buying themselves a ramped-up litigation program,” Ferrara added. “Let's hope they are ready for it,” he said. “Their litigation record is not stellar.”

Prudent Approach

However, other attorneys suggested that the likelihood of increased litigation is precisely why the SEC will be circumspect in applying its new policy. “Requiring admissions in SEC settlements runs the risk of seriously cutting the agency's annual case production numbers,” said Stephen Crimmins, a Washington-based partner at K&L Gates LLP. “For this reason, we can expect the SEC to proceed cautiously in requiring admissions.”

Nonetheless, Crimmins warned that “there will be some uncertainty” in the near term as to how the SEC will apply its policy change. “So this will bear close watching by defense counsel,” he said.

Similarly, Brad Bondi, a Washington-based partner at Cadwalader, Wickersham & Taft LLP, predicted that the SEC will demand admissions in only “rare instances where there is a corresponding criminal resolution or where there was truly egregious conduct” by senior executives. “The commission appreciates that an admission carries with it many collateral consequences,” he observed.

Washington-based lawyer Edward B. Horahan III also stressed that White did not suggest that the policy revision was a “huge change.” All that the SEC chair said was that certain cases no longer will be permitted to settle on a “neither admit/nor deny” basis, he said. “So I think it will be a slight expansion to what the agency has said in the past” regarding parallel criminal cases.

Investment Advisers

The concern over the SEC's policy change is shared by the regulated community. David Tittsworth, executive director of the Investment Adviser Association, told BNA that at this point, it is difficult to predict how the revision will play out, partly because decisions will be driven by the specific facts of each enforcement action.

Investment advisers are a group under close scrutiny by the SEC. According to Gibson Dunn & Crutcher LLP's 2012 Securities Enforcement Update, the commission in fiscal year 2012 filed a record number of actions--147--against investment advisers, representing 20 percent of the total number of enforcement cases brought last year.

Many questions remain to be answered, including what types of cases the SEC will deem to involve egregious intentional conduct, Tittsworth continued. “And it certainly seems likely that the targets of any such enforcement cases will have an incentive to aggressively fight allegations of intentional conduct due to the long-term adverse consequences, including reputational harm to a firm or individual or the increased likelihood of criminal proceedings that may flow from the SEC's proceeding.”

Given this reality, the SEC will have to balance the additional time, effort, and resources that may be required to prove intentional conduct with the desire to conclude cases in a more expeditious manner, Tittsworth said.

Welcome Development

In the meantime, plaintiffs' attorneys--not surprisingly--welcomed the SEC's policy change.

Given the increasingly heavier procedural difficulties that Congress and the courts have placed in the way of investors seeking to sue over securities fraud, investor plaintiffs will “greatly benefit to the extent that the SEC can obtain admissions by those participants of their wrongdoing,” said Ira Schochet, a New York-based partner at Labaton Sucharow LLP. He cited, for example, the greater insistence that plaintiffs be able to initially plead, without benefit of discovery, particularized facts that likely are known only to the fraud participants.

However, Daniel Sommers, a Washington-based partner at Cohen Milstein Sellers & Toll PLLC, warned that while admissions of liability could be extremely helpful to private litigants--especially where the investor must plead and prove that a defendant acted with scienter--much will depend on how the SEC implements the policy change.

“[I]t remains to be seen whether the SEC will be able to obtain such admissions in cases brought against substantial market participants such as large issuers and underwriters and it is in those instances where the new policy would have the greatest impact on private securities cases, including securities class actions,” Sommers told BNA. “On the other hand, if the SEC only obtains these admissions in smaller cases--such as Ponzi schemes--then it is likely that this new initiative will have relatively little impact on private cases.”